It's not the economy, stupid!

With the US economy dragging itself to its feet, the housing and stock markets crawling back, and the Republican presidential candidates (and their nationally syndicated Falstaff) doing everything imaginable to alienate most American women, President Obama has been having quite a run of good luck.  But there is one piece of good news clearly not welcome around the White House: new data showing that health care costs are stabilizing.

I know, I know – this is health care, costs are always out of control, and the sky is always falling.  What could I possibly be talking about?

I’m talking about the actual numbers.  The accompanying graphs reveal that health spending has actually been stabilizing for several years, and the system we all love to hate is finally re-entering the economy’s normal orbit after three decades of skyrocketing growth.

This of course is hardly a cause for celebration around the Obama Administration, for obvious political reasons.  Why else would economists from the same department tasked with implementing health reform choose to tell us that this long-awaited good news is actually – well – bad news.

Huh?  In both graphs below, newly released data through 2010 show that health spending over the past several years has been normalizing to the rate of overall inflation rather than outpacing it – or grossly outpacing it – as has been the case, nearly without interruption, since the 1970s.

It must be the recession! the government’s economists declare in their article accompanying the release of the numbers in the January issue of Health Affairs, an explanation dutifully repeated by the major media.  And of course it must be a travesty. Everything in health care is a travesty, after all – at least for the grim-faced technocracy addicted to health care’s myriad dysfunctions – and especially for those in an administration struggling to maintain political support for a plan branded for already insured voters as the “Affordable Care Act.”

Fortunately, the government number-crunchers are dead wrong, as is evident with only a cursory glance at their own data.

The graph on the left is based on numbers that economists from the Centers for Medicare and Medicaid Services published in Health Affairs. The graph shows the growth rate of annual national health expenditures trending down from 2007 to 2010, tracking perfectly spending declines during the Great Recession. To align this data with the conventional wisdom that health care costs are always out of control – and to assure us that only the recession could have interrupted health care’s otherwise perfect slow-motion economic disaster – the researchers also compress three prior decades of health care spending inflation into three single data points and label them as “1980, 1990 and 2000.”  That’s why we, not the editors of Health Affairs, added the vertical gray bar, to show where the scale on the x-axis changes.

Wait a minute! Doesn’t it seem odd that professionally competent economists writing for a responsible peer-reviewed journal would compress part of data on the x-axis of their main exhibit without readily noting it?  We thought so too; and so my research assistant spent 12 minutes downloading the government’s source data and breaking apart the actual numbers so we could look at the detailed trend. The result is the more complete graph on the right, derived from the same government database used in the published analysis – and yes, it tells an entirely different story.

Expanded to reveal what actually happened between 2000 and 2007, and we find that health spending has been cooling, slowly and steadily, since 2002. Oops! Turns out the recession has had nothing to do with a 10-year trend – one driven not by government inaction and then the recession and threat of “ObamaCare” – but by slow, steady, cumulative improvements in medical care and, as importantly, by the introduction of marketplace disciplines into the demand for and purchase of that medical care.

If the recession were actually relevant to these numbers and the demand for medical care were as elastic as for, say, autos or appliances, the trend line in both graphs would have fallen off a cliff in 2008 and 2009, along with the rest of consumer spending.  Rather, the numbers stabilized during the recession, as part of trend that began back in 2002.  I suppose the authors could have been even more reckless with their speculations, and argued with greater empiric precision that the perennial health care cost spiral finally stopped accelerating because of 9/11.

Better Medicine and Real Market Forces

What is really behind this economic normalization of health spending? What has occurred during the past decade, absent any government “overhauls” of the system? Three things (1) medicine has slowly, cumulatively been getting better; (2) insurers have been getting smarter about benefit design and consumer behavior; and (3) health care consumers have been watching their once blank-check insurance coverage morph into tough, cost-sharing plans – with economic consequences attached to every choice.

These numbers are not the result of an insurance pricing cabal falling apart, nor a collective pre-emptive reaction to the coming of “Obamacare,” nor the result of any grand “disruptive” strategy by health care executives and entrepreneurs thinking they are implementing last year’s business school twaddle.  This is health care simply self-correcting, slowly and tediously, nearly a decade after the failure of the great managed care experiment of the 1990s.  Contrary to the perennial doomsaying of the health care technocracy – and the whining of an older generation of physicians and hospital administrators hit by the recent intrusions of accountability and computerization – the health care system is, almost in spite of itself, getting better.  If the 1990s were all about micro-managing the supply-side of health care (e.g., insurers beating down on hospitals about lengths-of-stay), the 2000s have been all about macro-managing the demand side of the equation (e.g., insurers introducing large co-payments for expensive branded drugs when generics are available). And as proven in reverse by the other “war on drugs,” it is clear which strategy – managing supply versus managing demand – works better in a mostly free society.

Health care’s long, slow shift from supply to demand management was getting off the ground between 2000 and 2003 (cf. the graph on the right one more time) – as most of “managed care” was giving way to a renewed era of unlimited consumer choice and access – for an extra price.  Those with insurance were free again to choose whatever medical care they wanted, but this time using some of their own money. High-deductible health plans, Health Savings Accounts, “tiered” drug plans, new co-payments for just about everything – these were all hitting the marketplace the same years that health care inflation, as per the honest version of the numbers on the graph on the right, was starting to cool. So maybe, people discovered, going “out of network” really isn’t a matter of life-or-death, if it costs an extra $100.  Maybe the generic version of that drug might work just as well as the fancy new branded one advertised on TV.  Maybe a Physician’s Assistant in an urgent care clinic can diagnose a bad sinus infection for $25, a whole lot faster than an emergency room physician can for $1,250.

While health insurers scrambled to create new benefit designs to harness the power of these emerging consumer market disciplines, they were also running out of healthy new customers to sign up; and those they already covered were getting older and sicker.  Luckily, the insurers had all those new drugs at their disposal, many going generic, and some widely prescribed ones even going over-the-counter. Combine all these changes in the market in the early 2000s, and insurers finally started managing the bottom line by actually managing disease, not just money, the dominant strategy of faux managed care in the 1990s.

Because of the myriad moving parts in the health care system – in particular the pitifully belated introduction of computers, data, and informatics – we cannot disaggregate these factors to determine which of these factors have actually helped or hindered this economic normalization, and to what to degree.  But the aggregate impact is clear, and the normalization of health spending is indeed good news – notwithstanding a false explanation by government economists with a political agenda to find a black lining in any silver cloud crossing the health care landscape.

The only bad news is that this slow, steady correction over the past decade is too slow, not nearly deep enough, and does not address the real drivers of waste in health care: the juggernaut of administrative madness that is the employer-mediated, hyper-regulated, fragmented, localized health insurance colossus – the same wreck into which the Obama Administration wants to jam another 30 million people.

Most importantly, this trend a decade in the making contains our best bets for true health system reform. And if we really wanted to bend the health care cost curve in a more dramatic way, i.e., downward, and actually make insurance “affordable” – we would double down on all these bets. We would change the tax code so that people, not their employers, can fund their own tax-advantaged mix of health insurance and spending accounts. And we would allow them to purchase that insurance and fund those accounts in a national, competitive market, just like we do today with car insurance, with the typical plan design converging on one consumer dial: deductible vs. premium, with the rest going into a spending account.  Hand the average American family the $15,000 their employer is spending on their health care now, turn them loose with it in a truly reformed health insurance market, and watch what happens.

In very short order, the marketplace would finally break apart the health insurance colossus into the two very different things it has been trying for too long to be: insurance against serious medical problems, and a glorified group buying club for medical products and services.  This would amount to full liberation of the consumer market forces that are clearly starting to work, if only at the margins, in the byzantine health care mess we all love to hate.  Then we will see what happens to those health spending numbers.

With any luck at all, ten years from now we will have to futz with the y-axis on the graph, to illustrate the magnitude of the decline in overall health care spending.

J.D. Kleinke is a Resident Fellow of the American Enterprise Institute. He has been instrumental in the creation of four health care information organizations; served as a health care business columnist for the Wall Street Journal; advised both sides of the political aisle on pragmatic approaches to health policy and legislation; and authored three books about health care and medicine. His latest book is Catching Babies, a novel about the training of obstetrician/gynecologists.

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