Economic Efficiency

Medicare has reinforced a variety of inefficiencies that characterized the medical-care market into which it was introduced. Among these inefficiencies are: a focus on therapeutic as opposed to preventive medicine, a reliance on expensive medical technologies, hospital charges based on costs, the prevalence of solo and small-scale fee-for-service practices among physicians, the litigious environment of contemporary American medicine, and third-party insurers who insulate both medical-care providers and many of their patients from the most direct, troubling consequences of spiraling medical-care costs. Some of these tendencies are interdependent; fee-for-service practice, for example, lends itself to a therapeutic approach.

This lengthy list of features contributing to economic inefficiency, however, cannot be blamed on Medicare or public policy. Rather these inefficiencies derive from the practices of the private market that the program was designed to leave unchanged. Before examining the provider-related problems for economic efficiency, let us quickly survey the recipient-related economic issues.

Since it serves a population that is already retired or disabled, Medicare has limited effects on labor-market participation. Recipients' rates of use for particular medical services increased somewhat following the introduction of Medicare, but not dramatically. Since use of medical services is not limited simply by economic concerns, public sponsorship of medical insurance seems unlikely to stimulate use any more than private medical insurance available to well-organized workers.^[19]

By providing partial payment for highly specified services tailored to a recipient's immediate needs, rather than income that can

be freely used, Medicare would appear to have little affect on savings incentives. It is unrealistic to imagine that people fail to save because Medicare will cover a portion of the medical expenses they might subsequently experience. Nor could most people ever save enough to cope with the costs of extensive medical care.

Like any social insurance program funded in part by payroll taxes, Medicare may retard corporate or entrepreneurial risk-taking. But since Medicare costs employers less than one-third of the income-maintenance components of social security, its effects on the competitiveness of American goods and services in the global market are minimal.

In 1967 Medicare benefits cost $4 billion; by 1986 benefits had increased more than fifteenfold, to $76 billion.^[20] Serving about 36 million persons in 1986, Medicare consumed approximately 7.5 percent of the federal budget (compared to 20 percent for social security and 1.5 percent for AFDC) and just under 2 percent of GNP (compared to 5 percent for social security and less than 0.5 percent for AFDC). More than two-thirds of Medicare expenditures were for HI, nearly all of that for inpatient hospital care. Of the slightly less than one-third devoted to SMI most was spent on physicians' fees.

The dramatic growth in Medicare expenditures—outrunning inflation generally— is attributable to many factors, but increases in hospital and physicians' fees account for the bulk of it.^[21] Shortfalls in Medicare's trust fund are not far down the road,^[22] and the United States is already spending a greater proportion of GNP on medical services than many advanced industrial societies that provide national health insurance.

Medicare involves several forms of redistribution. From the perspective of individual recipients, HI is an example of life-cycle redistribution, but current practices also involve intergenerational transfers that probably cannot be recouped. Since the incidence of poverty among the elderly has now fallen to the level prevailing among the population generally, the vertical redistribution effected by federal subsidies for SMI is probably less than that entailed by AFDC. But since social security payroll taxes are more regressive than the federal income tax, SMI may contribute somewhat more to vertical redistribution.

As mentioned earlier, Medicare's economic inefficiency reflects

the program's relatively good fit with a sector of the private economy riddled by inefficient practices. This is an unusual predicament in a culture that tends to saddle public programs with charges of inefficiency. Even more unusual have been the efforts of the federal government to stimulate greater market efficiency in the private medical sector. Until recently, in contrast, private insurers have done little in this regard.

Federal initiatives to promote economic efficiency in the private medical sector have been of two types: measures to regulate and efforts to encourage price competition. To date, regulation has predominated. With respect to providers, the Nixon administration applied price controls as part of a more general scheme of economic intervention. His administration also developed Professional Standards Review Organizations (PSROs), which are primarily attentive to hospitalization statistics, and Health Systems Agencies (HSAs), which focus on capital investment decisions. President Carter was unable to secure legislation that would have limited hospital price increases, but the Reagan administration did enforce limits on the federal government's liabilities for Medicare hospitalization and has made modest moves in a similar vein with respect to physicians. These efforts have all helped somewhat to control costs, but the price of medical care has continued to outpace inflation.^[23] Sterner regulatory procedures (bargaining, explicit rationing, and centralized planning) are apt to be required.

As part of its overall effort to control costs, the federal government has also repeatedly raised Medicare premiums and deductibles, and it has kept allowable fees for various services from rising as rapidly as physicians' charges. As a result, Medicare recipients' out-of-pocket expenses have increased, and some analysts recommend increased patient copayments as a cost-control device.^[24] While copayments do reduce federal expenditures, they will not reduce the nation's aggregate health-care bill unless they deter use of services. But there is not much evidence that suggests elderly citizens flock to physicians unnecessarily by contemporary standards. The most prominent increase in services has been in the area of short-term hospital stays, a service attributable more to physicians' choices than to patients' actions.^[25] So copayments appear to be less effective at reducing unnecessary services than at shifting costs to patients.

The limited success of federal regulatory efforts has prompted some analysts and policymakers to suggest that restructuring the medical-care market for better price competition is the strategy most likely to achieve greater economic efficiency. Throughout most of the 1970s, policymakers looked hopefully at group practices, such as HMOs, that provide medical care for a fixed annual fee, thus placing a premium on preventive and ambulatory care. This internal incentive structure seems an encouraging mechanism for cost containment.^[26] Indeed, the most successful and widely known HMOs—Kaiser Permanente, for instance—have kept costs and cost increases well below those of conventional hospitals and fee-for-service practices.^[27] In some metropolitan areas competition among HMOs and between HMOs and conventional medical-care delivery practices has slowed the growth of medical-care costs.^[28]

Despite the interest of federal government leaders and other elites, only modest restructuring has occurred. Many private insurance carriers have integrated specific changes into their operations, but the federal government's repeated efforts to stimulate the development of HMOs have had little success. HMOs are complex, relatively fragile organizations that face difficult circumstances in the current medical-care market,^[29] and some efforts to stimulate new HMOs have constrained existing ones.

Competition and cost-conscious incentives have also led to new problems. Cutting costs by cutting care and self-dealing group practices are abuses every bit as disconcerting as price increases.^[30] Regulation is apt to be necessary under any system of delivering medical services, not just Medicare.^[31] For example, the activities of PSROs in isolating underuse and overuse of hospitalization can be as important in detecting shortcuts in care by HMOs as in detecting cost padding by fee-for-service practitioners.

Today, reformers insist that some sort of restructuring is necessary to improve the economic efficiency of the medical-care market. And almost all analysts interested in reform agree that the only actor with both a sufficiently strong incentive and the necessary organizational capacity is the federal government. Providers have no economic incentive, at least in the short run. Some members of the public have the incentive, but no organization. Insurance companies also have some incentive, but until recently have found it easier to pass along increased costs to their customers. For

the moment, Medicare is not large enough to provide sufficient leverage for a general restructuring,^[32] but some future national health insurance program might.