Wednesday, October 10, 2012

Inertia supports Baumol's disease

Steven Perlstein recently wrote a column for the Washington Post reminding us of a theory expounded by economists William Baumol and William Bowen, which has become known as "Baumol's Disease."  The idea, in short, is that there are some activities in society (like auto manufacturing and food production) that are subject to productivity improvements, and there are others (like education and doctoring) that are not as amenable to productivity improvements.  Everything else being equal, then, the percentage of a nation's spending that is devoted to the former will decline over time, while the percentage devoted to the latter will increase over time.

Baumol's theory was not the basis for my column a few days ago, in which I suggested that health care spending is likely to continue to rise in the developed nations.  I did suggest to a friend, though, that Baumol's idea might support the same type of conclusion.  He responded persuasively (to me at least):

Ahh, my theory is a little different, and I very much disagree that, "It’s hard, if not impossible, for them [education and health care] to be produced more efficiently". My theory is that costs escalate in higher ed and health care because the traffic will bear it--what would you not do for the health and education of your family? Providers have taken advantage of that to escalate costs and transfer wealth, and organized their value chains to maximize that transfer. It's very clear in higher ed: The colleges that you and I attended are far different, far costlier, and offer no better an education than 40 years ago. And while lifespan is longer, we are using greater and greater inputs of resources to eke out very small gains in outcomes, with huge variability and enormous non-value-added time, materials, personnel, etc. So no, I'm not buying the notion that "it will always take 23 minutes to play a sonata."

I agree with my friend because I have seen what happens when hospitals focus on providing a higher quality product.  If you do it well--improving quality and safety by reorganizing work in a thoughtful manner, relying on the thoughts and guidance of the front-line staff--there is a virtuous cycle with efficiency.  Waste is driven out of the system. Recall that my conclusion included this paragraph:

In all jurisdictions, the ability to deliver better value care will ultimately depend on the redesign of work in hospitals to improve quality and increase efficiency, whether by Lean principles or otherwise.  Unfortunately, this kind of approach will only be adopted by a small percentage of institutions.  It takes vision and leadership commitment, which are generally lacking in the industry.

So, Baumol is right, but he is wrong.  He is right that, as long as productivity gains do not occur in health care, its share of the national budget will grow.  He's wrong  if he thinks that the lack of productivity gains is immutable.  It is not immutable, but it is subject to a terrible degree of inertia.


Gary Nissen said...

Paul, I strongly agree with your friend, regarding "the traffic will bear it". I also see another slight spin -- in healthcare anyway, the decision makers (providers and patients) don't apply pressure to prices, and insurers don't have the power or will to do it either. This leads to higher prices and more services (sometimes unnecessary or ineffective).


Barry Carol said...

First, I wonder why prices per service, test or procedure are so much higher for U.S. hospital based care compared to the same care in developed other countries. Are U.S. hospital costs per licensed bed really that much higher and, if so, why?

Second, there are at least four cultural issues that drive up U.S. healthcare costs well beyond what they should be in my opinion. They are:

1. Executing a living will or advance directive and talking to one’s spouse and adult children about what care you want and don’t want in an end of life situation could eliminate a lot of futile and unwanted care at the end of life but 75% of us don’t do it.

2. A culture of litigiousness that makes too many people want to sue someone in the event of an unfortunate outcome even if the doctors and the hospital did nothing wrong. This results, in turn, in defensive medicine that pervades the medical culture.

3. A culture of fraud among too many providers that bills for everything from services never provided to unnecessary care to inappropriate upcoding.

4. A culture of opacity between insurers and providers that precludes the disclosure of actual contract reimbursement rates to both patients and referring doctors. Inefficiency is easy to sustain when price discovery is impossible and when someone else (the taxpayer or an insurer) is paying the bill.

Tom said...

Education and healthcare are largely paid for through wealth distribution using the tax code. Because we artificially decrease the price to the consumer of education and health care the demand and therefore the overall cost are both artificially high. There is little innovation in healthcare and education because there is no reason to innovate - the market is secured by propped up demand for the service. Until this dynamic changes neither industry will change.