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It’s been said many times but bears repeating. Expenditures are not costs. How often have you heard the claim, “health care costs in America are out of control?” I hear it a lot, and it is problematic for at least three reasons.

Reason #1: What the heck is health care? The forgoing claim treats “health care” as one big glob of stuff, each unit of which is indistinguishable from another. Doing this is akin to making the claim that “US GDP is …” as if all units of output are the same. Of course what this masks is that there are all kinds of goods and services that can correctly be called “health care” and it makes sense only to discuss the costs of each of these particular units. How has spending on MRIs changed over time, for example? Or how about spending on each doctor visit? And so on. There is simply no way to make an apples to apples comparison of health care today with health care in the past (or across countries for that matter) without talking about particularly what we mean.

Here’s an analogy – how much information would you learn by hearing, “Americans spend far more on sports than Italians do?”

Reason #2: Health Insurance is Not Health Care I often hear the health care cost claim couched in the language of high and increasing health insurance premiums. Indeed, I feel the bite of this myself. I am enrolled in a high-deductible HSA plan (a so-called “catastrophic” plan) and my annual premiums (family) for this policy exceed $12,000 per year! That is almost as much as a minimum wage worker, working a full 2,000 hours in a year, could earn in an entire year! But again, health insurance is not health care. Rather, it is a jumbled way of paying for particular aspects of the health care system (I say particular because a healthy diet and exercise regime are very much health care behaviors and almost nothing is said about these in the “costs are out of control” literature). Do rising insurance premiums reflect an underlying cost problem? Perhaps. But those premiums themselves really do not say anything about health care costs.

Reason #3: Expenditures are Not Costs The most important point is that expenditures are not the same as costs. When you hear the expression, “health care is 17% of GDP” what that means is that the dollar value of all health care goods and services purchased in the US is 17% of the total dollar value of everything purchased in the United States. Now, it is possible that this reflects an increase in costs, but it is by no means a certainty. Why? Because the dollar value captures the price (or cost) of health care services times the quantity of health care services purchased.

So why don’t expenditures equal costs? Two reasons. First, even if the cost of any particular health care service is the same today as in the past, we are consuming a far larger quantity of services today than in the past. If you take expenditures to be P x Q and and we add more Ps and Qs to the mix, then of course health care expenditures are increasing. For example, today we have medicines like Lipitor to help keep down blood pressure due to cholesterol buildup, and Americans spend millions of dollars per year on it. Does that mean that “health care costs” are higher today than in the past? We did not have Lipitor 40 years ago and therefore did not spend anything on it.

The second reason is related to the first – when we talk about “Q”, the quantity of health care services purchased, we have to assume that the quality of goods over time remains unchanged. This is what folks have in mind when they argue that American health outcomes are actually worse than in other countries. But quality is measured imperfectly when we do national income accounting. Is a heart surgery today really the same quality as a heart surgery of the past? Even if the surgery itself does not prolong life, is the recovery time lower? Is the pain less? Are the chances of infection lower? And so on.

Put starkly, the only way that someone could correctly argue that “health care costs are larger” in the United States today than in the past is to identify particular health care products and services and to compare how the actual cost of providing the same quality and quantity of that good or service has changed over time. In other words, for the claim to be true, one would have to argue that to produce a heart bypass surgery today uses more real resources than to produce an identical heart bypass surgery in 1980. You would have to demonstrate that tylenol uses more real resources to produce today than in 1980. And so on. Real economic costs are actions taken by an economic agent that consume real resources. This is entirely different than discussing how much money is exchanged in a large sector of the economy over time.

But explaining this distinction is not glamorous, it doesn’t make for a nice soundbite on Fox News or CNN, and it certainly doesn’t sound great for supporting whatever one’s preferred vision of social ordering of the world is. So we never hear it. That’s too bad. Because to use health care’s share of national income (increasing) as a crisis indicator is akin to arguing that education’s share and the environment’s share of national income increasing are also signs of a crisis. And I’ve yet to hear that point made. Indeed, one typically hears just the opposite. Funny, isn’t it?

5 Responses to “Expenditures are Not Costs”

  1. Harry says:

    What is really scary is that government people think they can do a better job of delivering “it”.

    To them, it is a simple task of imposing price controls, allowing fair, but not excessive! compensation for everybody, according to a fair schedule that accounts for the value of their labor, from the fork lift driver in the Pfizer warehouse to the cardiac surgeon doing the bypass. Sure, we can’t do that perfectly. The NHS has made a few mistakes. This time it will be different because we have bigger computers.

  2. jb says:

    Yes, it is a tedious argument. You need examples. We are spending way more no doubt, on hypertension today versus 200 years ago. But then point out that today we prescribe clinically tested cutting edge prescription drugs proven to extend human life for many years. 200 years ago it was a guy with a jar of leeches in his hand.

    The close of the blog is great. I would like to see data on spending for, say environmental remedition now versus 30 years ago. If we are spending more now, is that a “crisis”? Education is even better. When school budgets increase it is never considered a crisis, invariably it is considered desirable because it is “for the kids”. In my town actually reducing a school budget is practically considered child abuse. But when medical spending increases it is considered to be a bad thing because, what, it is for the old and infirm?

  3. Rod says:

    My brother-in-law Ed was the inventor and developer of multiple genetic tests that used the same blood spot that all newborns in the country implant on a piece of filter paper. When my son and his two sons were born, the “standard of care” only required that that blood spot be used to test for Phenylketonuria, or PKU, a condition that can cause mental retardation in newborns but that can be treated to neutralize its effects in newborns’ first hours and days of life.

    At first, he worked with a physician in Buffalo, NY, who had developed ten other tests that could be made from the same blood spot. The problem was that the standard of care in Buffalo and in Pennsylvania did not require those tests, so it was optional for parents to choose to have them done. The key was that the tests were cheap — about a quarter apiece — so that the eleven tests were often the cheapest thing on the maternity bill.

    Ed then worked for a hospital in western Pennsylvania that allowed him to develop other tests on the same bloodspot. He then set out to sell the battery of tests to hospitals and physicians in Pennsylvania, and he managed to get the state to add a test for Maple Syrup Urine Disease, a condition relatively common among the Amish in Lancaster County. After a few more years, his tests became the standard of care not only in Pennsylvania but in other states as well. At any rate, the charge for the test is still cheap — under thirty dollars, I think, up from ten bucks when he started in Buffalo. It’s an example of how technology can actually lower both a cost and an expenditure in a little corner of healthcare.

    At any rate, the “standard of care” rules what happens in all aspects of medicine, and all too often that standard is dictated by legal liabilities. When I was in the hospital last winter and spring for my broken leg, I watched a lot of television, and maybe twenty times an hour or more there was some lawyer advertising on the cable to get people to call 1-800- bad drug. I also had endless tests in the hospital — four CAT scans, X-Rays, and blood tests — all to make absolutely certain that nothing was going south in my care. Now, I did not mind most of it, but after the second CAT scan, you’d think they ought to have analyzed every inner part of my body.

    Also, I had four nurses assigned to my care after I first went into the hospital. There was an RN, an LPN and two others who mostly talked for hours outside my door between eleven p.m. and four in the morning. One of them was assigned to keeping track of my urine. The other one did hardly anything at all. Some lawsuit had probably determined that four people was the standard of care. Later on, when I had plastic surgery to close the incision in my ankle, I was in the ICU and had just one nurse at a time assigned to me. Go figure.

  4. chuck martel says:

    Dr. Lewis Thomas, head of the Harvard Medical School and regular contributor to the New England Journal of Medicine, had some thoughts about health care way back in the anti-deluvian days of 1976: http://nailheadtom.blogspot.com/2010/09/lewis-thomas-talks-about-health-care.html

  5. Harry says:

    The advocates of socialized medicine do confuse costs from expenditures. Deep down they want to dictate prices. To be fair, even they know they cannot control the price of everything down to the price of the cotton that goes into the sterile cotton ball, but if they believed that cotton growers were making obscene profits, they would go after them, too. Instead, the cotton growers are assisted by the socialists at the USDA.

    They are also not go after nurses who are represented by the SEIU; ditto for the hospital maintenance crew, the people who drive the trash trucks, and the orderlies. Now that Jack Welsh is gone from GE, and since GE is not making as much money as it used to, and since Sino-oriented Jeff Immelt is a honcho in government, they, like Sauron, have diverted gaze toward others who bother them more: medical doctors, especially specialists, but also family doctors; ethical drug companies; and medical device companies that are not subsidiaries of GE. All make too much money. If only they could apply simple standards of fairness to those greedy people, it would be easy to provide free health care to everybody not already covered by Medicaid, Medicare, SCHIP, etc., etc., including sex-change operation and some plastic surgery procedures, but nothing having anything to do with trans-species experimentation. Chiropractors would be included for those under age 77.

    Once they get the doctors under control, expenditures can go up. The next step is to raise taxes on the next group who are making too much money, maybe short sellers who made money shorting Merck, Genentec, MiniMed, and J&J. You can see where this is going.

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