Why Healthcare Is Broken in the U.S.

"We say, 'we want longer life, we're willing to pay for it,'" Anupam Jena told Investopedia in early August. "If our life expectancies were greater than other countries', then that might very well be a tradeoff we were willing to make."

There's a problem, though, explains the economist and Harvard Medical School associate professor of healthcare policy and Massachusetts General Hospital physician: even though the U.S. spends more per capita on healthcare than other rich countries, our life expectancies are the same or worse.

According to the OECD, the U.S. spends $9,892 per person on healthcare, a good bit more than the club's average of $3,997 (at purchasing power parity).

Yet life expectancy at birth is 78.8 years, short of the OECD's 80.6-year average. 

Things aren't getting cheaper, either, if current trends hold. The medical component of the consumer price index (CPI) has risen much faster than the overall index in recent years, meaning that medical inflation outstrips overall inflation.

Of course, few Americans need to see the stats to be convinced that their healthcare system is out of wack, particularly if they need an EpiPen, have ever tried to figure out what a test will cost, or watched the news at any point in July. That there is a problem is clear. It's much less clear what exactly that problem is.

Investopedia reached out to three health economists and a pharmacist-turned-entrepreneur to get their diagnoses. They hit on seven major sources of dysfunction.

Going to the doctor "is not like going to buy a car or going to buy a refrigerator," Jena says. "You can weigh all the options, you understand what it means for a refrigerator to have an ice maker that does this or does that, but it's much more difficult to say, 'well, I'm not sure whether or not this treatment will work,' or 'do I really need to get my cancer care at a Harvard teaching hospital?'"

Economists refer to this problem as information asymmetry. The problem is present to a greater or lesser extent in the market for almost any good or service, but it's especially acute in healthcare. If cars are complicated and error-prone, they are nothing compared to the human body. Mechanics possess a significant amount of specialized knowledge, but doctors are legally required to undergo years of training, obtaining advanced degrees and then working in supervised settings. Their patients, however savvy, seldom know enough to feel comfortable questioning a doctor's recommendations. When consumers feel compelled to purchase whatever sellers recommend – the stakes are high, after all – prices tend to drift upwards.

This imbalance is most visible in drug pricing. Michael Rea, a pharmacist and CEO of Rx Savings Solutions, says that a market is efficient if "people have access to information in a way that they can digest, process and make decisions off of. And with prescriptions drugs that's just not the case." He rattles off a number of factors that muddy the waters: rebates, benchmark pricing, AWP, MAC, WAC (those are average wholesale price, maximum allowable cost and wholesale acquisition cost, which are "somewhat arbitrary" and don't "necessarily mean anything"). 

Rea uses blood pressure medications as an example. Even if "we have the exact same conditions and are otherwise the same," the best choice can vary "because of the way your insurance plan functions and the way mine does and the way it preferences drugs." It's not as simple, he adds, as "if you just did this, everything would be okay."

Closely related to the problem of information asymmetry is the principal-agent problem. The doctor is the one with best information on what ails a patient and what treatment that patient needs. The patient is likely to go with the doctor's recommendation, since that's the best information available to them. But the doctor is not the one paying for the treatment. The "principal" (the patient) is stuck with the bill for the choice the "agent" (the doctor) makes on their behalf. "A doctor's not facing the cost when they decide to order that test," Jena says, "when they're deciding to send you to the hospital." 

In some cases doctors consciously ignore the costs of the tests and treatments they order – if they even know them – in order to focus on providing care. In other cases, poorly structured incentives encourage healthcare providers to splurge. "Payments are based on the quantity of services they provide," says Marah Short, associate director of the Center for Health and Biosciences at Rice University's Baker Institute, "and there's no good measurement of quality."

Erin Trish, an assistant research professor at the University of Southern California's Schaeffer Center for Health Policy and Economics, traces another cause of healthcare's dysfunction to a trend that's gathered speed in recent decades: consolidation. "So back in the 90s, most hospitals were independently owned, sole-site hospitals," Trish says. Why exactly the tie-ups began isn't certain, but one theory is that the emergence of managed care put an end to a system under which "the physician or hospital just billed the insurer for whatever they did and the insurer paid it."

For a while, Trish says, healthcare spending grew at a slower rate, but providers "didn't like where this was going." Hospitals began to form chains, and the process accelerated in the 2000s. Today hospitals are "an incredibly consolidated market," which allows them to charge more.

Another problem Trish identifies is widespread ignorance of how expensive healthcare actually is. "There is an insulation from the cost in a lot of ways, particularly among people with private insurance through their employers." As with hospital consolidation, history is largely to blame. During the 1940s, Franklin D. Roosevelt used wartime presidential powers to freeze wages – except for "insurance and pension benefits." Since labor was scarce, firms rushed to one-up each other with generous health insurance policies. Then the IRS ruled that workers did not have to pay taxes on premiums their employers paid, and from 1940 to 1946 the proportion of Americans with health insurance tripled to 30%.

It did not take long for the system to become entrenched. "My guess," says Trish, "would be that if you surveyed the average person who gets their health insurance through their employer, they probably don't have a great sense of what that health insurance premium costs and also how much their employer is actually contributing to the premiums."

This insulation from the true costs of healthcare isn't limited to those who get insurance through employers, though. According to a recent National Bureau of Economic Research working paper by Amy Finkelstein of MIT and Nathaniel Hendren and Mark Shepard of Harvard, enrollees in Massachusetts' subsidized insurance exchanges are willing to pay only around half of their own expected medical costs.

To explain why healthcare – and drugs in particular – are so much more expensive in the U.S. than elsewhere, Jena points to the sheer moneymaking potential drug makers find in the U.S. market. 

"Most health economists would agree that healthcare spending and healthcare spending growth come from new innovations in healthcare," he says, giving coronary stenting and the hepatitis C medication Sovaldi as examples. "If you think about what drives innovation in healthcare, as in any other sector, it's going to be profits. So when profits are higher, companies are more incentivized to invest in a technology."

The U.S. is around half of the world healthcare market, so it is a crucial source of these profits. Jena says that when a country with similar per-capita wealth to the U.S. – Switzerland or the Netherlands, for example – pushes down the prices of drugs, innovations continue apace, because the profits derived from these countries are "a drop in the bucket." If the U.S. were to do the same, though, profits would take a big hit, and innovation would slow. This is the innovation-access tradeoff: because the U.S. is such a lucrative market, it must choose between cheap access to drugs and the promise of better drugs down the line.

That tradeoff leads into a related issue: what economists call the free-rider problem. "It's hard to come up with a model whereby the UK should be spending less on drugs than the U.S. is spending" per capita, says Jena. "The only reason that happens is because they don't face the innovation-access tradeoff, because whatever decisions the UK makes don't impact the likelihood of future innovation."

In other words, Americans are subsidizing cheap drugs for other countries.

This dynamic doesn't only play out internationally. There are a great deal of people within the country who use healthcare services without paying for them in full: free riders. The Affordable Care Act attempted to tackle free riding in the insurance market by requiring that everyone obtain health insurance or pay a penalty (rather than just using emergency room services), but in a broader sense the problem persists. Medicaid and CHIP, taxpayer-funded programs providing healthcare to low-income people, covered over 74 million people as of June. 

That much of the country does not see such free riding as a problem gets to the heart of why healthcare is different. For many, it is a human right, and inability to pay should not prevent people from receiving a basic standard of care. "Who in their right mind would say that we shouldn't be covering people who are poor and don't have access to healthcare if healthcare were really inexpensive?" says Jena.

But healthcare is not really inexpensive, and plenty of people in their right minds question how the country can continue to provide subsidized care as costs rise. In normal markets, rising costs depress demand as consumers find substitutes or do without. When it comes to healthcare, there are no substitutes, and doing without can be a painful or fatal proposition. So demand is inelastic: if a consumer needs a treatment, they will go into debt to pay for it, or pursue more creative means. The premise of that quintessentially American drama, Breaking Bad, wouldn't have made much sense outside of the U.S.

"It's really hard to tell somebody that they're not going to get a treatment because they can't afford it," says Trish. "And when you're not willing to say no, that influences both the spending and utilization that result, but also the prices that are negotiated."