Are Price Controls the Answer?

A recent article in Time magazine by Steven Brill, "Bitter Pill: Why Medical Bills Are Killing Us," is a brilliantly written expose of the excesses and outrages of health care pricing. In reaction to the story, some have suggested the price controls are the appropriate (or the only) way to rectify the situation. A recent story in the Washington Post's Wonkblog, "Steven Brill’s 26,000-word health-care story, in one sentence," suggests that US health care costs and cost growth are so high because we do not use rate setting, i.e., price controls.

In fact, I think it's not easy to establish whether that is indeed the case. We don't get to use randomized controlled trials for health policies or systems, so it's difficult to figure out how effective a policy like rate setting is. Let me start with some simple examinations of patterns in data to see if something jumps out that strongly supports (or contradicts) the assertion that price controls reduce health care costs.

Starting at the most aggregate level, we can compare the growth rates of spending across countries that use price controls for health care with those that don't. The figure below shows the growth rates of health spending for OECD countries from 2000-2009. The US is the main country with a substantial part of its health sector not subject to price controls. Spending by the privately insured in the US is about 50% of the total, so about one-half of our health spending is not subject to price controls. The Netherlands deregulated prices in their hospital sector starting at 10% in 2005 and moving to 34% in 2009, and also for many physician practices, although it's not clear whether the 2000-2009 growth rate reflects any effects.

There does not appear to be a revealing pattern here -- there are some countries that use rate setting, such as Australia, France, Israel, and Italy that have lower growth rates than the US, and some such as Canada,  Finland, and the UK that have higher growth rates. The US is below the OECD average, whereas Finland is above, as is The Netherlands. While I wouldn't put much weight on anything we see in cross-country differences (there are way too many differences across countries besides price controls), nonetheless nothing striking emerges from these numbers.

Another possible source of information on the effect of price controls on spending is the Medicare program. Medicare fixes the prices it pays doctors and hospitals, so it controls prices. The figure below shows per enrollee growth rates for personal health care expenditures from 1970-2011, as calculated by CMS for services covered both by Medicare and by private insurance (Source here, Table 21).



While examining this figure is clearly not a scientific test (there are many other things undoubtedly driving growth rates of spending), nonetheless, if we see Medicare growth rates consistently lower than private growth rates that would lend at least some preliminary support for the notion that rate setting controls costs. As can be seen, sometimes Medicare spending per enrollee grows faster than private spending, and sometimes the opposite. In particular, Medicare spending slowed dramatically in the mid-1980s after the introduction of the Prospective Payment System for hospitals. Private spending growth fell below Medicare in the early to mid-1990s, most likely due to managed care. More recently Medicare spending has grown more slowly than private spending. Over the entire period the average Medicare growth rate is 8.02%, while private is 9.34%. The patterns here are mixed, but the long run average growth rate for Medicare is lower.

The US does have quite a bit of experience with price controls for medical care at the state level, so we can look at evidence on the effectiveness of these programs. Many states used all-payer rate regulation for hospitals during the 1970s and 1980s. The evidence from these state hospital rate regulation programs indicates a mixed pattern of success. The setup and administration of the program played a large role in whether they were effective. Nonetheless, there is evidence that fi nds that mandatory rate regulation program in a number of states did reduce the rate of growth of hospital expenses (by a little more than 1%). I provide a few references here, for those who are interested. While a 1% reduction in spending growth rates isn't very dramatic, if such an effect occurred and was sustained over time it would lead to a substantial decrease in spending over time.This is probably the most relevant evidence, since if rate setting were to be revived it would almost certainly happen at the state level.

This effect of rate-setting pales, however, compared to the estimates of the impact of managed care from a prominent study, "How Does Managed Care Do It?," which found 30-40% lower expenditures (not growth rates) due to managed care in Massachusetts in the mid 1990s. Another prominent study, "Price and Concentration in Hospital Markets: The Switch from Patient-Driven to Payer-Driven Competition," finds that hospital markups fell substantially in California in the 1980s, primarily due to the growth of managed care.

So what do we conclude? My answer is that we don't know what the impact of rate setting (price controls) would be on health care spending in the US. It's possible that rate setting could prevent some of the most egregious practices recorded in the Brill article, but that depends on what's enacted and how it's enforced. Whether rate setting would substantially slow the rate of growth of health care spending isn't clear. Further, the question that must be asked is what is the alternative? There's evidence to suggest that robust price competition, such as we had with managed care during the 1990s, can perform very well in controlling costs. Unfortunately there has been a tremendous amount of consolidation in health care markets since the 1990s, raising serious challenges to competition. Whether the US decides to go with competition or with regulation, we have some serious work to do to make the system we choose work effectively.