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Healthy Competition

What's Holding Back Health Care And How to Free It

by Michael F. Cannon and Michael D. Tanner

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What's Holding Back Health Care And How to Free It
Michael F. Cannon and Michael D. Tanner

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What's Holding Back Health Care And How to Free It
Michael F. Cannon and Michael D. Tanner

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Excerpt: Healthy Competition


What's Holding Back Health Care and How to Free It


Copyright © 2007 Cato Institute
All right reserved.

ISBN: 978-1-930865-81-5


Acknowledgments...........................................................viiPreface to the Second Edition.............................................ixForeword  George P. Shultz................................................xiIntroduction: What Can Competition Do for Patients? 1Part I   The State of America's Health Care System1. What's Right...........................................................172. Real Problems..........................................................27Part II  Misdiagnosis3. How Not to Reform Health Care..........................................33Part III Underlying Diseases, Strong Medicine4. Too Much of a Good Thing Can Be Very Bad...............................515. Tax Policy and Health Care.............................................676. Government Health Programs.............................................817. Choice and Competition, or Controls?...................................1158. Medical Malpractice Reform.............................................143Conclusion................................................................149Notes.....................................................................153Index.....................................................................179

Chapter One

What's Right

As noted earlier, many critics of free markets conclude America's health care system demonstrates that free markets are an inferior way of providing medical care. Though inaccurate, this misperception is based on a partial truth. More than any other developed nation, America relies on private institutions and market mechanisms to deliver medical care. The harmful effects of government influence are significant, yet the successes of America's relatively market-oriented approach to health care bear mentioning.


By many measures, the United States has the finest health care system in the world. Most of the world's top doctors, hospitals, and research facilities are located in the United States. In the past 10 years, 14 of 25 recipients of the Nobel Prize for Medicine have been U.S. citizens. Four more practice in the United States. American research and development, particularly in the pharmaceutical field, has produced the majority of medical breakthroughs over the past 50 years. Of the 152 major medicines introduced worldwide over the past 20 years, U.S. companies developed nearly half. Eight of the 10 top-selling drugs worldwide in 2002 were produced by U.S. firms, and Americans played a key role in eight of the ten most important medical advances in the past 30 years.

Nearly every type of advanced medical technology or procedure is more abundant in the United States than anywhere else in the world. Figure 1.1 shows the relative availability of technologies such as magnetic resonance imaging (MRI) units and computed tomography (CT) scanners on a per capita basis in various countries.

If you are diagnosed with a significant illness, the United States is the place you want to be. For example, cancer patients are less likely to die from the disease in the United States than in other countries. Figure 1.2 shows the mortality-to-incidence ratios for breast, prostate, and colon cancers, as well as AIDS. The United States also seems to fare well in comparison to other nations when it comes to treating heart attacks and lung cancer.

It should come as no surprise, then, that patients all over the world seeking advanced medical care come to the United States for treatment. One U.S. hospital alone, the Mayo Clinic, treats roughly 7,200 foreigners every year. Johns Hopkins University Medical Center treats more than 6,000. Nearly one-third of Canada's doctors have sent a patient abroad for treatment, often to the United States, and Canadian governments and patients spend more than $1 billion every year on medical care in the United States.

Common Misperceptions

Despite its strengths and consensus about some of its shortcomings, persistent misperceptions abound in debates over America's health care system. Perhaps the most prevalent is that America spends more on health care than other advanced nations but gets less in return. There is truth to this criticism as well: America does spend more on medical care than other countries, in both absolute and per capita terms, and much of that spending is wasted. The reasons America likely spends too much on health care, why we often get less than full value for our health care dollar, and some remedies are discussed later. It is important first to refine the critique by examining the first part of this myth: that spending more than other nations is in itself undesirable. In fact, high levels of medical spending are often a good thing. The second half of this myth-that other nation's health care systems outperform America's-is also worth debunking.

Is Spending More Necessarily Bad?

The United States has, by far, the most expensive health care system in the world, whether measured as a percentage of gross domestic product (GDP) or as expenditure per capita. As a percentage of GDP, U.S. health care spending (16 percent in 2005)9 is more than six percentage points higher than the average of other industrialized countries (Figure 1.3). Overall health care costs have outpaced GDP growth by more than four percentage points, on average, in the last five years and now total $2 trillion per year-more than consumers spent on housing, food, or automobiles, and more than the federal government spent on national defense.

There are a number of reasons why high levels of health care spending should not be troubling or should even be seen as positive. Health care is considered a "normal good," meaning that spending is positively correlated with income. As income rises, people tend to demand more health care. The amount Americans spend on health care is to a large degree a reflection of America's wealth. Princeton University economist Uwe Reinhardt and scholars at Johns Hopkins University found that 90 percent of the variation in health spending among OECD nations "can be explained simply by GDP per capita." All by itself, America's high per capita GDP is enough to make its per capita health spending higher than any other OECD nation's, and accounts for 47 percent of the difference in per capita spending between the U.S. and the OECD median.

An aging population also contributes to higher levels of health care spending. Gains in life expectancy increase that part of the population that consumes the most medical care (the elderly).

Technological advances in medical care also contribute to rising health care expenditures. Advances in medical care enable providers to aid patients for whom they could previously do little. Such advances call forth additional spending because they improve and lengthen lives. "The sickest person in the economy in 2002 is much more costly to treat than the sickest person in 1950 because technological progress has significantly shifted out the frontier medical condition that can be treated," writes U. C. Berkeley economist Charles Jones.

Mark McClellan and Harvard University economist David M. Cutler posit that the benefits of technological advances overwhelm the added costs. They estimate that advances in technology meant that every additional dollar spent on treating heart attacks in the 1980s yielded the equivalent of $7 worth of increased longevity and quality of life. Advances in the treatment of depression and even expensive new treatments for low-birth-weight infants yield benefits worth six times the cost. And every dollar spent on cataract surgery yields more than $30 in benefits for patients who live an additional five years, and greater benefits among those who live longer (see Figure 1.4). Frank Lichtenberg of Columbia University estimates that from 1980 to 1992, every additional dollar spent on pharmaceuticals was associated with a $3.65 reduction in hospital expenditures. Lichtenberg also estimates that the benefit-cost ratio of general medical expenditures is nearly 14 to 1 while the ratio for pharmaceutical research and development is more than 100 to 1. Mark Duggan and William Evans of the University of Maryland found that anti-AIDS drugs introduced in the 1990s were cost-effective despite a threefold increase in Medicaid spending on HIV patients. In these and many other cases, new technologies led to higher health care spending. Yet the additional spending often reduced the costs borne by patients.

Improvements in cardiac catheterization enable patients with heart disease to be treated younger, return to work faster, and live longer. Increased availability of pacemakers and commercial defibrillators has also contributed to a significant reduction in deaths due to heart disease. Lichtenberg estimates new drugs account for as much as 40 percent of the increase in longevity in 52 nations from 1986 to 2000. Jones estimates that between one-half and three-quarters of the growth in medical care expenditures from 1960 to 1997 was due to medical advances that enabled patients to get more per dollar spent. "Technology often leads to more spending," Cutler and McClellan write, "but outcomes improve by even more."

At the same time, technology often lowers prices. The inflation-and quality-adjusted price of treating heart attacks declined at a rate of just over 1 percent each year from 1983 to 1994. Other studies have found similar effects with prices for cataract surgery and depression.

These productivity gains do not mean that America's medical marketplace is devoid of waste. Expensive new pharmaceuticals are often prescribed to patients who would do just as well with less expensive alternatives. Or waste may occur in routine, preventive, or other areas of medical care, such as unnecessary diagnostic tests or patients obtaining treatment in an emergency room rather than a less expensive clinic. In Chapters 4-6, we discuss how America's health care sector wastes billions of dollars and some of the reasons why. However, large productivity gains do suggest that much of America's health care spending is not wasted but is in fact very well spent. "Even if you take all the waste out of health care," Cutler notes, "the spending would still go up because we have a technology-intensive system that will continue and is delivering a lot of benefits in terms of longer, healthier lives."

A final reason that high health expenditures need not be problematic has to do with America's leading role in medical innovation. As the 2004 Economic Report of the President notes, "while all countries can benefit from research and development expenditures made by a single country, only the health expenditures in the innovating country will include the costs of research and development. Health expenditures in non-innovating countries will exclude the research and development costs."

Many express alarm at rising health care spending, yet most would agree that higher incomes, longer life expectancy, and increased health care productivity are positive developments. Further, America's status as the world leader in developing new medical technologies, and foreigners coming to the United States to purchase medical care, are reasons to applaud additional health care spending. Though America's health care system engenders considerable waste, it is equally clear that many health care expenditures yield impressive returns.

Does the U.S. Spend More but Get Less?

The most important factor in evaluating how much a nation spends on medical care is whether it gets its money's worth. Critics of the U.S. health care system point out that despite large expenditures America does not compare well with other nations on such measures as life expectancy or infant mortality. For example, the Organization for Economic Cooperation and Development reports that the United States ranks below most other industrialized nations in infant mortality.

Such measures, though, do not reflect the return America receives on its investment in health care. The cross-national comparisons on which such criticisms rely often are not direct comparisons, and often do not control for contributing factors unrelated to a nation's health care system. A significant portion of the gap in infant mortality rates is explained by what various nations consider a "live birth." The United States tends to include in its measure of live births extremely low-birth-weight infants whom other nations seem to exclude. One study noted that across 23 European countries "there are many indications of differences in recording and reporting live birth, fetal death, and infant death within the European region of the [World Health Organization]. Even when [standardized] recommendations are adopted as the legal definition, some countries have incomplete registration or reporting of events."

A more useful comparison of different health care systems is how well they cope with the same problem, such as infants of a given birth weight. Nicholas Eberstadt of the American Enterprise Institute notes that controlling for birth weight shows that the United States does a better job than other nations. "By comparison with other Western societies enjoying especially low rates of infant mortality, U.S. babies at any given birth weight appear to have unusually good chances of surviving the perinatal period, regardless of race," Eberstadt writes. "All other things being equal, this would seem to suggest that medical care for infants in the United States is actually rather better than in some other advanced industrial societies."

Comparisons of life expectancy are also of limited use. There is little correlation among advanced nations between health care expenditures (whether absolute or as a share of GDP) and life expectancy (see Figure 1.5). The United States spends more than 14 percent of GDP on health care compared with South Korea's 6 percent, yet females born in the two countries have roughly the same life expectancy (79.8 years vs. 80.0 years). However, Poland, Slovakia, and Mexico each spend a share of GDP similar to South Korea's (6.1 percent, 5.7 percent, and 6.1 percent, respectively), yet have slightly lower life expectancies (78.8 years, 77.8 years, and 77.1 years, respectively). Turkey spends a slightly larger share of GDP (6.6 percent) on health care than South Korea, yet life expectancy for females is almost a decade less (70.9 years).

The actual amount spent per person on medical care would seem to be a more helpful predictor, but even this measure shows little correlation with life expectancy. Life expectancy for females born in Denmark is on par with those born in the United States (79.5 years vs. 79.8 years) even though per capita health care expenditures in Denmark are half what they are in the United States ($2,580 vs. $5,267) (see Figure 1.6). From this comparison, it would seem Americans could live longer by spending less. Yet consider Japan and the United Kingdom. Each spends roughly the same amount per capita on medical care ($2,077 vs. $2,160) yet life expectancy in Japan (85.2 years, the highest of any nation) is nearly five years more than in the U.K. (80.4 years).

Clearly, there are variables other than health care spending that determine infant mortality rates and life expectancy, including genetic attributes, nutrition, and how nations spend their health care dollars. A better measure of a nation's health care system is how it performs when confronted with particular medical challenges. As noted earlier with regard to cancer patients and low-birth-weight infants, evidence exists that the United States outperforms other nations.

Chapter Two

Real Problems


There is little misperception about the direction of health care costs. A 2004 survey found that while economists believe terrorism presents the greatest short-term risk to the economy, "In the longer run, the rising elderly population and related health care costs are the primary problems." In another poll, more Americans expressed as much concern over health care as over terrorism and national security. The paramount concern is the cost of health insurance: "Americans are increasingly dissatisfied with the cost of health care." For most of the past 18 years, the cost of employer-based health insurance has risen faster than workers' earnings and inflation. Year-to-year increases in health premiums routinely exceed 10 percentage points. In one survey, "Fifteen percent of employers said that they offset premium increases with smaller raises for their employees." Health insurance has become increasingly burdensome for employers and consumers alike.

Perhaps more troublesome is the obligation of government health programs. Medicare is the federal program that provides health care subsidies to the elderly and disabled. Medicaid is a joint federal-state program of health care for the indigent. Each program places a large and growing burden on taxpayers. In 2006, the federal government spent a combined $554 billion on Medicare and Medicaid (not including the State Children's Health Insurance Program, a Medicaid offshoot). That is more than Congress spent on national defense ($520 billion). When state Medicaid spending is included, these two programs cost taxpayers an estimated $692 billion in 2006, more than one-quarter more than Social Security ($544 billion) (see Figure 2.1). According to the Congressional Budget Office, Medicare spending will double from the 2007 levels in 10 years and federal Medicaid spending will nearly double in nine years. If current trends continue, Medicare and Medicaid alone could consume 12 percent of GDP by 2030.